Here's Why We Don't Think ENAV's (BIT:ENAV) Statutory Earnings Reflect Its Underlying Earnings Potential

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing ENAV (BIT:ENAV).

We like the fact that ENAV made a profit of €74.8m on its revenue of €767.6m, in the last year. The chart below shows that both revenue and profit have declined over the last three years.

View our latest analysis for ENAV

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what ENAV's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

A Closer Look At ENAV's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

ENAV has an accrual ratio of 0.28 for the year to September 2020. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of €74.8m, a look at free cash flow indicates it actually burnt through €270m in the last year. It's worth noting that ENAV generated positive FCF of €216m a year ago, so at least they've done it in the past. The good news for shareholders is that ENAV's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On ENAV's Profit Performance

ENAV didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that ENAV's true underlying earnings power is actually less than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 29% over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 2 warning signs with ENAV, and understanding them should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of ENAV's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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